Part 3: Financial Projection and Stock Valuation
This is a continuation of the stock report on Acadia Pharmaceuticals (ACAD), which was published last week (Acadia Stock Report: Business Overview And Revenue Projection).
Let's first review Acadia's financial statements (ACAD 10K 2012, ACAD 10Q2013). In 2012 (ending December 31), ACAD reported $4.9M in revenues from collaborations. It had a net loss of $20.8M, with combined R&D and SG&A expenses of $25M.
As described in revenue projections, we estimate that total revenues for ACAD will be $9.6M (2013), $9.6M (2014), $89M (2015), $178M (2016), and $300M (2017). As the company expands its clinical programs, we estimate that the company's combined R&D and SG&A expenses will be maintained at about 52%-54% of product sales. This translates to an operating margin of 28%, which is in line with comparable companies. Assuming tax rates are in the 10%-12% range, the net profit margins are ~25%. Therefore, the projected earnings per share are -$0.22 (2013), -$0.21 (2014), $0.27 (2015), $0.48 (2016), and $0.72 (2017). In other words, Acadia could turn profitable in 2015, the first year its drug is in the market.
Equity offerings and shares dilution:
Acadia has a history of raising capital through stock offerings rather than debt issuance. As a result, the shares outstanding and total issued shares have increased at an astonishing rate. For example, the company issued 17M shares in 2011, resulting in an increase of shares outstanding from 39.4M to 52.9M (or a 34% increase). In 2012, the company raised $17.7M by issuing 5.3M shares. This brings total shares outstanding to 73M (or a 38% increase). In May 2013, the company raised an additional $108M (9.2M shares), increasing its outstanding shares to 83M (or a 13.7% increase). The takeaway for ACAD investors is that one should be prepared to see further dilution of shareholder equity as the company expands its clinical program, unless it finds a corporate partner who is willing to fund its operational costs.
Going forward, ACAD will need funding for conducting pimavaserin Phase III trial for schizophrenia indication and Phase II trial for Alzheimer's disease psychosis. The management stated in its 2013 second quarter report (ACAD 10Q2013) that the company has sufficient cash and cash-equivalent investments ($200M) to fund its operations into 2015. So, it is likely that no further equity offerings will be needed until 2016. Nonetheless, we assume that the company's shares outstanding will continue to increase at an average of 5M shares per year. Investors therefore should be prepared for sequential dilution of their equity ownership going forward.
Now, let's look at ACAD's balance sheet. As of June 2013, the company had approximately $207M total assets, which includes $205M cash and marketable securities, as well as $181M of shareholder's equity. Due to long-term losses, the accumulated deficit now stands as $383M. This is common for early stage biopharmaceutical companies before they turn profitable. ACAD has no long-term debt, as the company prefers using equity financing rather than debt financing.
The above table summarizes the projected data inputs used for stock valuation. ACAD cash flows from operations (CFO) are estimated to be between $84M and $170M from 2015 to 2017. We also factor in capital expenditure to be 2.5% of the cash flow to operation. After subtracting capital expenditures from its CFO, ACAD's free cash flows increase from $82M (2015) to $167M (2017). The free cash flow numbers were used to derive ACAD's intrinsic value.
We utilized the Discounted Free Cash Flow model to derive ACAD's intrinsic equity value. Based on the free cash flow numbers from 2013 to 2017, a long-term growth rate of 5% and a 16% discount rate, the estimated per share stock value is ~$31.
The fair value is greatly impacted by long-term growth rates. For instance, a 5.5% growth rate would elevate the fair value to $32, whereas a 4.5% growth rate would bring down the fair value to $30.
We applied a 16% discount rate for ACAD's valuation. As a reference point, we usually assign a 10%-12% discount rate for mature pharmaceutical companies with at least 2-3 drugs in the market (e.g. JNJ and Pfizer). We assign a 14%-16% for mid-cap companies with Phase III programs. For small- or mid-cap companies with Phase II programs, we assign an 18%-20% discount rate. Again, discount rates have significant impact on fair value. A 15% discount rate will elevate the intrinsic value to $35, whereas a rate of 17% will reduce the value to $27.
ACAD is currently trading at $23.5 as of 9/18/2013. This price represents a 25% discount to its intrinsic value as calculated in this article.
Acadia's primary revenue driver will be the successful approval and launch of its wholly-owned drug candidate pimavaserin for the treatment of psychosis associated with neurological disorders. The company plans to file for an NDA toward the end of 2014 for Parkinson's disease psychosis. Assuming the drug is approved by the FDA, the drug can be in the market by 2015. At present, the company has only 26 employees, so the company will need to hire a sales force or partner with another pharmaceutical company to co-market the product. Alternatively, the company could be acquired by another company that is looking to add a drug to its pipeline. These options will become apparent when the drug is up for regulatory decision in 2014-2015.
Obviously, ACAD's value hinges on one drug. Any setback to its clinical program could send the stock into a nose dive. We assign an 80% probability that the drug will be approved by the FDA. Investors need to factor in the potential risk associated with ACAD if the drug fails to receive FDA approval.
Another unique aspect for Acadia is its financing method. The company has primarily used stock offerings to raise capital. As such, the company has no long-term debt, but has significantly diluted shareholders' equity. We suspect that the trend will continue as the company seeks to expand its clinical development programs.
Based on our earnings projection and stock valuation, we derive an intrinsic value for ACAD at $31. At current stock price of $23.5, ACAD is trading at about a 25% discount to its intrinsic value.